Tuesday, April 28, 2009

Ruminations on Nonprofit CEO Compensation

This story in the Triangle Business Journal, like many other stories in the press over the past several years, raises the specter of tax-exempt nonprofits (in this case, hospitals), losing exemption because of "excessive" CEO compensation.  Unfortunately, the stories almost uniformly misinterpret the law, present the facts in the most sensational manner possible, and generally "get it wrong."  I understand that reporters are busy, that they believe they need to inform the public about issues, that particularly in this era of TARP, executive salaries are a "hot" issue, and that this area is complex.  But you'd think that after several years of this, someone would put in the effort to learn the issues, and quit writing the same wrong stuff time after time after time.


The story in the Triangle, like virtually all the press stories, get their sensationalistic spin from both the absolute amount of compensation (in the case of the two hospitals mentioned in the story, WakeMed and Duke, over $1 million annually for each CEO) and the comparison to other nonprofit CEO salaries (which are almost always lower; those who study nonprofit organizations understand that salaries for nonprofit hospital administrators outpace every other nonprofit salary, which shouldn't surprise anyone: many nonprofit medical centers are huge businesses, generating hundreds of millions or billions in revenue and employing thousands of people).

But the law in this area quite clearly states two things.  First, it is not the absolute amount of compensation that is the issue.  The issue is whether the compensation package as a whole is "reasonable."  And second, "reasonable" in these cases is measured not by just a comparison to other nonprofit salaries, but also a comparison to salaries in the for-profit sector.  The regulations could not be clearer on this point: 

“The value of services is the amount that would ordinarily be paid for like services by like enterprises (whether taxable or tax-exempt) under like circumstances (i.e., reasonable compensation).  Section 162 standards apply in determining reasonableness of compensation . . . .”  Treas. Reg. § 1.4958-4(b)(1)(ii) (italics added).  

In fact, the regulations under Section 4958 provide a safe-harbor provision for compensation arrangements if the arrangement is approved by an independent board or compensation committee of the board that relies on “appropriate data as to comparability prior to making its determination” and documents the basis for its decision.  Treas. Reg. § 1.4958-6(a).

There is a legitimate theoretical issue regarding whether nonprofit executive compensation should be measured against for-profit compensation.  The arguments here are not hard to understand.  On one hand, some assert that keeping charitable management salaries below those of the for-profit sector helps insure that managers retain the “special ethic” of charities as serving their constituents rather than making a buck, and makes sure the maximum amount of money is used for services to the beneficiaries of the charity, whomever they may be (e.g., more free or discounted care for the uninsured poor, in the case of hospitals).  The counter-argument is that such limitations artificially condemn charities to hiring “second rate” management since they will be unable to compete with for-profit firms for the top managerial talent.  Put more starkly, would you rather have your quadruple-bypass surgery done by the head of cardiology who makes $1 million per year, or by a heart surgeon whose salary has been artificially limited to $100,000 per year?  Yeah, I thought so.

But these theoretical arguments about what the law should be do not alter what the law is today.  And under the law as it exists, most of the press stories about nonprofit executive compensation give a false impression that the salary in question violates legal standards.  And that, folks, is both sloppy reporting and not very helpful to the real issues at hand, which in the case of nonprofit hospitals, have more to do with the underlying tests for exemption and whether nonprofit hospitals should be exempt at all, than what hospital executives get paid.  

JDC

http://lawprofessors.typepad.com/nonprofit/2009/04/ruminations-on-nonprofit-ceo-compensation.html

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Comments

Good points, all. A more technical one is that, as I recall, the compensation regulations do not even apply to entities that are also exempt from tax as state instrumentalities. So I'm not even sure what governs the pay of executives at state universities and teaching hospitals, other than general private inurement principles.

Posted by: BDG | May 3, 2009 8:38:42 AM

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